Fra Steen Jakobsen, Saxo Bank:
- Conclusion: A new negative double whammy is impacting markets and risk. First is the realization that the break-down in trade talks is already pointing to a a massive disruption of the global supply chain and a halt in “technology transfer”, Second, and only in part due to the US-China trade war risks, the world is heading full-tilt into a recession light, if not a full blown recession:
- Why does it matter: Fed and global central banks are increasingly behind the curve and will move to do what they can (for the non-NIRP banks at least) aggressively cut policy rates. We see the Fed cutting by – at least – 50 bps by October.
- Action: Remain long overweight US fixed income and unhedged (i.e., accepting currency risk) and add to overweight @ break of 129.50 in the TLT (US Long Treasury ETF) on daily close. Remain defensive in stocks & position for policy change from monetary policy to fiscal policy by Q4-2019 (infrastructure spending- and early inflation)
Since our change to a Global Policy Panic narrative in December, we have been long/overweight US fixed income. Liking both the path of lower rates and stronger US Dollar (which historically strengthens when Fed shifts into an easing cycle). With US interest rates collapsing we remain long because of a strong chance of recession, not only in the US, but globally.
After the initial risk-on impact from the Global Policy Panic, we moved to the The False Stabilisation theme in April – arguing that Lowering the guidance and the future price of money wouldn’t be enough, when the real issue is credit facilitation still falling. Using our dependable measures of the credit impulse, we still insist that the trough in economic activity lies ahead of us, not behind. (The credit impulse in the chart below shows an suggests a low in the August/September time frame)
If the credit impulse correctly predicts the timing of this low, the next policy action is likely to arrive around the same time: still lower global policy rates led mainly by China and the US. It’s important to realize that we don’t really have a business cycle any more, only a credit cycle and that credit leads and predicts nearly everything. The barrier for a cut appears high at the moment as the Federal Reserve seems to be on a misinformation campaign – I asked my Bloomberg for the top Fed news headlines in recent days to get a feel for where FED stands – below is the result:
Two things are surprising. First is how neutral/hawkish the Fed still sounds. Second, and probably more relevant, why are two top people, one a real contender for New York Fed President and both with over 25 years at the Fed leaving on such short notice? But let’s go back to the point – the Fed is either clueless or faking it to avoid a new destabilizing melt-up in equities, as economic data points domestically and globally to a steep deceleration:
Here is the Chicago Fed National Activity Index – the broadest measure of US economic activity – it has moved into negative (Forget the chart headline – data is updated not the headline!)
Furthermore the market is not only calling the Fed’s bluff – they are even raising the bet that the Fed will not only cut once but at least twice this year…..
Chart: TLT vs. FED Near-term spread (Or bond market vs. Fed likelihood of cutting rates)
Comment:
Chart shows that although TLT is coming back strong, it needs to break 129.50 to start the final climb to the 2016 high of 143.60 – which I expect it could eventually exceed.
Finally,
We at Saxo Bank have always said that the world leading gauge of economic activity is Australia and in the currency space AUDJPY. That exchange rate is making new lows @ 75.50, soon testing the 72.50 low of 2016, more interesting though – the RBA and RBNZ have always been leading in cutting rates as global growth comes under pressure, not least in 2008 (not including the Fed here -but non-Fed central banks) as this morning excellent piece by David Fickling, Bloomberg: The Rich World’s Canaries are starting to look sickly shows. The RBA, by the way is expected to cut rates next Tuesday for the first time since 2016.
These two charts don’t need additional explanation:
RBNZ cut in July 2008 – the RBA followed a few months later in September.
The 10-year Australian government yield is really down under, having collapsed to an all-time lows below 1.50% over the last week – below the RBA’s current short policy rate before next week’s cut!.
Conclusion
This double whammy for markets – the already recessionary tilt for the global economy that is only being aggravated by trade war risks – has yet to be fully priced by the market. I continue to get research in my inbox hailing the resilient US economy. But the reality is that both the Fed and Wall Street are behind on adjusting to a global scenario where the engines of credit growth, that is lower rates, cheap energy and globalization, either no longer prevail (globalization and arguably energy) or have reached the point of diminishing returns (low rates).
Next up is an attempt to trot out the same old policy recipe: Lowering of policy rates, resulting if we are luck in a brief “sugar high” in asset markets. But ultimately this just extends the narrative of the False Stabilisation until perhaps October, which coincides with the US federal budget season. The next policy pivot, likely to more thoroughly dawn on the market at that time even if there has been plenty of chatter for the last couple of quarters, will be massive fiscal spending, built on an MMT framework that means overt stimulus not sterilized with the issuance of US treasuries.
